Insurance Coverage for Real Estate Defect Nondisclosure Claims

This mad dash for housing could lead to a lot more home buyers being unpleasantly surprised by defects the seller allegedly misrepresented or failed to disclose. Will a seller’s insurance apply to a purchaser’s nondisclosure claim? In most cases, courts have answered “no.” However, this area of coverage litigation often creates difficult questions of policy interpretation.

The Insuring Agreement

The insuring agreement in many liability policies, including most homeowners policies, covers an insured’s legal liability for damages because of “property damage” or “bodily injury” resulting from an “occurrence.” These terms are heavily litigated in all manners of coverage disputes, and nondisclosure claims are no exception.

Is There “Property Damage” or “Bodily Injury”?

The typical homeowners’ insurance policy defines “property damage” to require physical damage to tangible property. Most courts to address the issue have held that misrepresentations or omissions about the condition of property result in only economic losses, not “property damage,” and therefore are not covered. In Boggs v. Great Northern Insurance Co., 659 F. Supp. 2d 1199 (N.D. Okla. 2009), for example, the court held that the buyer’s nondisclosure claims were “for the costs associated with repairing the [defect], which are economic damages.” The same result frequently follows in states, such as California, that limit recovery in nondisclosure actions to economic damages.

Harder questions are presented by cases involving undisclosed conditions that create subsequent damage. Several courts have reasoned that nondisclosed conditions which result in physical damage after the alleged misrepresentation was made—such as a water leak—may constitute “property damage” under the seller’s liability policy. In one memorable case, the court held that coverage was triggered for property damage caused by an undisclosed infestation of raccoons. Jares v. Ullrich, 667 N.W.2d 843 (Wis. Ct. App. 2003).

Undisclosed conditions that result in post-sale bodily injury may also trigger coverage. In one extreme case, a buyer was assaulted by a man from an adjoining condominium unit who broke through a common attic wall, and the buyer sued the seller for misrepresenting the existence of a firewall. An appellate court held the seller’s homeowners insurer owed a duty to defend. Sturt v. Grange Mut. Cas. Co., 761 N.E.2d 1108 (Ohio Ct. App. 2001).

Was the Damage or Injury Caused by an “Occurrence”?

Policies typically define an “occurrence” as an accident, and many definitions also contain some variation of “repeated exposure to harmful conditions.” In nondisclosure claims, coverage will often turn on whether a court considers the “occurrence” to be the property defect or the seller’s misrepresentation. Most courts treat the misrepresentation as the “occurrence” and deny coverage, reasoning that a verbal or contractual misrepresentation cannot cause damage to property. That is, a crack in the foundation might cause a basement to leak, but a seller’s lie about the leak does not. Kentucky Farm Bureau Mut. Ins. Co. v. Blevins, 268 S.W.3d 368 (Ky. Ct. App. 2008).

On the other hand, a few courts have deemed the defect itself to be an “occurrence.” In these cases, coverage is frequently found when an unknown defect results in property damage or bodily injury. See USAA Cas. Ins. Co. v. McInerney, 960 N.E.2d 655 (Ill. App. Ct. 2011).

Did the Damage or Injury Take Place during the Coverage Period?

Another common issue in nondisclosure cases involves identifying when the property damage or bodily injury happened, for purposes of triggering coverage. This analysis is complicated by the fact that nondisclosure claims, by their very nature, often allege harms that happened after the seller transferred possession of the property and canceled the seller’s homeowners coverage. For example, the court in Allstate Insurance Co. v. Hicks, 134 S.W.3d 304 (Tex. App. 2003) held a buyer’s alleged “bodily injury” from mold exposure did not occur during the policy period of the seller’s homeowners insurance. But in Creamer v. Arbella Insurance Group, 120 N.E.3d 1239 (Mass. App. Ct. 2019), the court held that a heating oil spill—which allegedly began while the sellers owned the property—triggered coverage under sellers’ homeowners’ insurance.

Courts have formulated several different “trigger” theories to attempt to analyze the date of loss, leading to disparate results depending on the prevailing theory. For example, the “injury-in-fact” trigger theory focuses on when the damage occurred, while the “manifestation” theory looks at the date the damage becomes apparent. Other theories (such as the “exposure” or “continuous trigger” theories) chart a middle ground.

Exclusions

Even when a nondisclosure claim alleges an “occurrence” causing “property damage” or “bodily injury,” common policy exclusions may bar coverage. For example, a nearly universal exclusion applies to harm “expected or intended” by the insured. A seller’s intentional misrepresentation about a defect will almost never be covered, although most intentional nondisclosure complaints include alternative allegations of negligence or breach of warranty that might not implicate this exclusion.

Another common policy provision excludes coverage for liability arising under a contract or agreement. This exclusion might bar indemnity for the seller’s nondisclosure liability, given that home-sale transactions tend to involve detailed contracts with long disclosure forms. However, a court could find the contract exclusion inapplicable where the seller’s liability is based on statutory disclosure requirements or common law tort theories, as opposed to breach of contract or breach of warranty. Also, many homeowners’ policies contain an exception to this exclusion for contracts related to the ownership, maintenance, or use of the insured property. What the policy takes, it can give back.

Many homeowners’ policies also exclude coverage for damage to property owned by an insured. The application of an “owned property” exclusion may depend on whether the alleged damage occurred before or after the sale (which, as discussed above, is not always a straightforward answer). Compare American Family Mut. Ins. Co. v. Sharon, 596 S.W.3d 135 (Mo. Ct. App. 2020) (owned property exclusion did not apply to post-sale flooding damage), with Shelter Mut. Ins. Co. v. Ballew, 203 S.W.3d 789, 793 (Mo. Ct. App. 2006) (no coverage for seller’s alleged failure to disclose pre-sale defects). Some policies also exclude coverage for damage to property an insured “sells, gives away, or abandons”—thus avoiding the pre-sale / post-sale coverage dilemma. See State Farm Fire & Cas. Co. v. TGF Enters., LLC, 954 N.W.2d 899 (Neb. 2021).

What about the Buyer’s Insurance?

This article concentrates on liability coverage for seller nondisclosure claims but practitioners should be aware that different issues are presented when the buyer makes a “first party” claim under his policy for damage arising from an undisclosed condition. Homeowners’ policies separately define the risks that are covered for property loss and contain a separate set of exclusions. For example, many policies exclude first-party coverage for loss caused by latent defects. Disputes also arise over whether damage occurred during the policy period. As with all claims, the specific policy language is critical and attorneys evaluating coverage must carefully review the insurance policy as the starting point.